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What are Audit Assertions? Balance Sheet and P&L assertions explained.

Audit Assertions are a representation by management that is embodied in the financial statements. These representations may be explicit or not. Assertions are used by the auditors to assess misstatements and to obtain evidence.

Audit Assertions are about:

  • Items appearing in the profit or loss statement,
  • Items appearing in the balance sheet, and
  • Presentation and Disclosures.

Before we dive in deeply, let me answer some of your common questions!

There are 5 profit and loss assertions.
P & L statement assertions.
What are audit assertions?

Audit Assertions are claims made by the management in their financial statements. These claims may be implicit (not directly stated but implied) or explicit (directly stated). You know, it is the responsibility of management to provide financial statements to external auditors. They present certain information in these financial statements. This information carries both explicit and implicit meanings. This is what we call audit assertions. Management wants to tell the auditors that their revenues, as well as expenses, occurred actually and are complete, accurate, properly classified and recorded in the correct period. similarly, they also have certain audit assertions about the balance sheet and disclosure. We are going to cover each of them.

What are the five audit assertions?

The five audit assertions are:
1. Occurrence
2. Completeness
3. Accuracy
4. Classification &
5. Cutoff
These are audit assertions related to profit and loss statement.

What are the audit assertions for expenses?

The audit assertions for expenses are:
1. Completeness
2. Accuracy
3. Classification
4. Occurrence &
5. Cutoff
As expenses relate to the profit and loss statement, so audit assertions for expenses are the same as profit and loss statement assertions.

What are Audit Assertions for Revenue?

Audit Assertions for Revenue are:
1. Classification
2. Cutoff
3. Occurrence
4. Completeness
5. Accuracy
Did you notice? I just rearranged the sequence of these five audit assertions. Revenues, as well as expenses, relate to profit and loss statement, so they both have the same 5 audit assertions as a profit and loss statement.

Sacred Accounting will discuss each of the above categories of assertion in detail.

Profit and Loss Assertions

Profit or loss statement shows profit or loss for the period. There are five profit or loss assertions viz occurrence, completeness, accuracy, classification, and cut-off. You are reading this article because you want to know what audit assertions you need to consider whilst conducting an audit of profit or loss statement. This is why sacred accounting have explained each of these assertions in detail (A little bit though!).

Occurrence

The assertion that all the transactions and events recorded in the financial statements, have occurred and are related to the entity is called occurrence.

This assertion is tested for an overstatement. In simple words, if management has recorded a transaction related to profit or loss statement, you need to check its occurrence which will ensure two major things:

  • That transaction recorded by management actually occurred, and
  • That transaction actually relates to the entity (it means management is not showing someone else’s transaction in their profit or loss statement.
Occurrence Assertion of profit and loss statement
Occurrence Assertion

Example of Occurrence Assertion

This is pretty much simpler, as I mentioned, you just need to confirm two things:

  1. These sales of worth $5,000 actually happened
  2. These sales worth $5,000 actually relates to the entity.

But how will you do this? well, you need to select a sample of entries from the sales ledger of the entity. After this, you need to match these entries with supporting documents like sales invoices, goods dispatch notes, and customer orders, etc.

Completeness

The assertion that all the transactions that should have been recorded are recorded is called completeness.

This assertion is tested for any understatement. To put it in simple words, if accounting standards require that a transaction should be recorded, it should be recorded and a profit or loss statement will be considered as complete if all such transactions are recorded.

Example of Completeness Assertion

Consider the same example of sales worth $5,000 (as mentioned above), how will you test the completeness assertion?

Come on, you can do it, you just need to select a sample of customer orders and match it with sales invoices and goods dispatch notes. You should also check its posting into the general ledger.

Did you notice the difference?

  • We traced entries to underlying supporting documents in case of testing occurrence assertion whilst,
  • We traced customer orders to invoices and then its posting into the general ledger.

Why is this difference in relevant tests important?

This is because:

  1. We need to trace entries in the general ledger to supporting documents to ensure that these transactions actually happened, and
  2. we traced customer orders to its posting into the general ledger to ensure that transactions are recorded completely.
Completeness is an audit assertion profit and loss statement.
Completeness Audit Assertion

Accuracy

Assertions that all the transactions are events are recorded with the appropriate amount. A transaction is considered accurate if:

  1. There is no error while preparing the supporting document, and
  2. There is no error while posting this transaction.

Example of Accuracy Assertion

Considering the above example (sales of $5,000), how will you test the accuracy?

This is pretty much simple as we need to perform the following steps:

  • Select a sample of entries from Sales Ledger.
  • Recalculate the amount on sales invoices, and
  • check whether control accounts reconciliations are in place.
Accuracy is an important audit assertion related to transactions during the period.
Accuracy Audit Assertion

Classification

The assertion that transactions and events have been recorded in their own proper accounts. It means there is no misclassification of any transaction and event. If a transaction relates to purchasing activities, it must be included in the purchase ledger, similarly, all entries related to sales should be recorded in sales ledger (not anywhere else).

Example of Classification Assertion

Considering our previous example of $5,000 sales, we will test classification by selecting a sample of sales invoices and will trace its posting to the sales ledger. As we perform audit procedures on other line items of profit and loss statements as well, we will confirm the posting of every transaction in the correct head.

Classification audit assertions means every transaction is correctly classified.
Classification Audit Assertion of P & L

Cutoff

The assertion that all the transactions and events have been recorded in the correct accounting period. It means transactions appearing in the current year profit or loss statement actually relate to the current accounting period.

cutoff audit assertion means that every transaction is recorded in the correct period.
Cutoff Audit Assertion of P & L statement

How to Test Cutoff Assertion?

Select the last five transaction of the closing period and first five transactions of the coming period, then ensure they are recorded in the correct general ledgers. Make sure the last five sales are really the last five sales recorded in the sales ledger. Similarly, make sure that the first five transactions are the first transactions appearing in the sales ledger of the next period.

Profit and loss assertions example

What is written in the profit and loss statement?

Suppose NHIRKM Engineers has made sales worth $40,000 in the period ending 31 Dec 2020.

What does Management want to tell us?

  1. These sales (worth $40,000) actually occurred.
  2. All the sales are recorded in the p & l, so it’s complete.
  3. All these sales are valued at an accurate amount.
  4. Nhirkm Engineers has classified all the transactions related to sales only & only in the sales category.
  5. All the sales of $40,000 pertain to the current period i.e. 2020.
Profit and Loss Assertions Example
Example of profit and loss assertions

How will we Test profit and loss assertions in the above example? The following 2 images describe it a lot!

5 Audit Assertions Related to Profit and loss
Definition of Existence, Completeness and Accuracy Assertions with relevant tests
Audit Assertions related to Revenue items
Classification and Cutoff Audit Assertions

Balance Sheet Assertions

Balance sheet or statement of financial position has 4 assertions. Let me explain all the balance sheet assertions through an example:

There are 4 balance sheet assertions
Balance sheet assertions are 4 viz Existence, Completeness, Valuation & Allocation and Rights & Obligations.

Existence Assertion

Existence is the assertion that all the assets, liabilities and equity recorded in the statement of financial position actually exist.

  • This assertion means that there has been no overstatement of assets, liabilities and equity items.
  • This assertion is very closely related to occurrence assertion for transactions.

How to Test the Existence Assertion?

Select a sample of assets from Fixed Assets Register (FAR) and check whether these exist physically.

Completeness Assertion

This means that all assets, liabilities and equity items that should have been recorded are actually recorded in the statement of financial position.

How to Test Completeness Assertion?

During physical verification of fixed assets, pick some assets on a random basis and trace whether they are recorded in the balance sheet.

Valuation and Allocation

Assertion It means that all assets, liabilities, and equity are recorded at the correct amount, and any adjustments relating to the valuation of assets, liabilities, and equity have been recorded.

How to Test Valuation and allocation Assertion?

Select a sample of fixed assets from Fixed Assets Register and obtain vouchers to perform vouching of their purchase costs. Similarly, recalculate depreciation expense and loss/gain on disposal (if any). Obtain the breakup of any additions made to fixed assets during the period. Then perform vouching on a sample basis to ensure the accuracy of the amount.

Rights and Obligations Assertion

This audit assertion means that all the assets, liabilities and equity presented by the entity in the statement of financial position actually belongs to the entity. To simplify this, we can say that:

  • All the assets appearing in the balance sheet belongs to the entity.
  • All the liabilities or obligations recorded by the entity, actually pertain to the entity.

How to Test Rights and Obligations Assertion?

Check the ownership documents of fixed assets on a sample basis and ensure they belong to NHIRKM Engineers.

Balance Sheet Assertions Example

What is written in the balance sheet?

Suppose NHIRKM Engineers has fixed assets of $50,000 as at 31 Dec 2020.

What Management wants to tell us?

  1. These fixed assets actually exist.
  2. All the fixed assets are recorded in the b/s, so it’s complete.
  3. All these fixed assets are valued and allocated correctly.
  4.  Nhirkm Engineers has all the rights of these fixed assets.
Assertions for Balance Sheet
Example of Balance sheet Assertions

We will test all these 4 assertions of balance sheet item i.e. fixed assets below with all the relevant assertions defined.

4 Assertions of Balance Sheet
Existence, Completeness, and Valuation & Allocation Assertions of Balance Sheet
Assertions for Balance Sheet defined
Rights and Obligations Assertion of Balance sheet

Assertions about Presentation & Disclosure

There are four Audit Assertions about Presentation & Disclosure.

Occurrence and rights and obligations

It means that every event, transaction and any other matter disclosed by the management actually exist and pertain to the entity.

Completeness Assertion

This Assertion means that all necessary disclosures have been made by the management in the financial statements.

Accuracy and Valuation

It means all the disclosures have been made at the appropriate or correct amounts.

Classification and understandability

By classification, we mean that all the transactions have been categorized correctly. Similarly, understandability means that all the disclosures are clearly expressed.

Kamran Ullah

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